Economic rent

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Economic rent is defined as an excess distribution to any factor in a production process above the amount required to induce the factor into the process or continue its current use.^[1] Economic rent is closely related to producer surplus, but is measured in input units rather than output units. Privatized economic rent, especially when derived from natural resource ownership, is the quintessential unearned income.^[2]

Contents 1 Classical factor rent 2 Neoclassical Paretian rent 3 Land rent 4 Example 5 Brief summary of historical avoidance of the matter 6 Detailed historical terminology 7 Terminology relating to rent 8 See also 9 External links 10 References

[edit] Classical factor rent

Classical factor rent is primarily concerned with the fee paid for the use of fixed (e.g. natural) resources. The classical definition is expressed as any excess payment above that required to induce or provide for production.

• "A payment for the services of an economic resource which is not necessary as an incentive for its production"^[3]
• "Any payment that does not affect the supply of the input"^[4]
• "A payment to any factor in perfectly inelastic supply"^[5]

[edit] Neoclassical Paretian rent

Neoclassical economics extends the concept of rent to include factors other than natural resource rents. But the labeling of this version of "rent" may be somewhat opportunistic or simply incorrect in that Vilfredo Pareto, the economist for whom this kind of rent was named, may or may not have proffered any conceptual formulation of rent.^[6][7]

• "The excess earnings over the amount necessary to keep the factor in its current occupation"^[1]
• "The difference between what a factor of production is paid and how much it would need to be paid to remain in its current use"^[8]
• "A return over and above opportunity costs, or the normal return necessary to keep a resource in its current use" ^[9]

[edit] Land rent

In political economy including physiocracy, classical economics, and other schools of economic thought excepting neoclassical economics, land is recognized as an inelastic factor of production. Rent is the distribution paid to freeholders for "allowing" production on the land they control.

As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land (...) ^[10].

David Ricardo is credited with the first clear and comprehensive analysis of differential land rent and the associated economic relationships (Law of Rent).

Johann Heinrich von Thünen was especially influential in developing the spatial analysis of rents, which highlighted the importance of centrality and transport. Simply put, it was density of population increasing the profitability of commerce and providing for the division and specialization of labor that commanded higher municipal rents. And the high rents determined that land in a central city would not be allocated to farming, but would be allocated instead to more profitable residential or commercial uses.

Observing that a tax on the unearned rent of land would not distort economic activities, Henry George proposed that publicly collected land rents (land value taxation) should be the primary (if not the only) source of public revenue.

[edit] Example

The generalization of the concept of rent to include opportunity cost has served to highlight the role of political barriers in creating and privatizing rents. A person seeking to become a medical doctor makes a huge sunk cost investment in medical training and education, which has limited potential application outside of medical practice. In a competitive market for medical services, a doctor's wages would be set at where the expected net return on the sunk cost investment in training would be just enough to justify making the investment. In a sense, the required investment is a natural barrier to entry, discouraging some would-be doctors from making the necessary investment in training to enter the competitive market for medical services. This is a natural "free market" self-limiting control on the number of physicians and/or the cost of training necessitated by certification. Some of those who would have opted for a medical career may well decide to be lawyers or business people or technologists.

However, restrictions on the numbers of people entering into the competitive market for medical services has the effect of raising the return on investments in medical training especially for those already practicing by creating a politically contrived scarcity of physicians. This kind of political activity to the extent that it exists is termed rent-seeking. To the extent that a constraint on entrants to the medical profession actually increases the returns to physicians as opposed to insuring competence, then to that extent the practice of limiting entrants to the field is a rent seeking activity, and the excess return realized by the physicians is economic rent as herein defined.

[edit] Brief summary of historical avoidance of the matter

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Private property creates enables land owners to collect rent. While the physiocrats were inclined to recognize the implications of this privatization in regard to taxation and production, classical economists were not concerned with studying how the economy actually works; not how laws could make trade more fair for the poor. Smith mentions economic rent in only in passing, as does Ricardo. In the 1800s Henry George published on the economic implications of land-based taxation and urged its adoption to alleviate poverty. Neoclassicical economists generally dismiss the writings of Henry George, claiming that George does not present a coherent economic theory, is advocating for tax policy changes to benefit one class over another, and that his tax policy would exacerbate the poverty George intended to alleviate. Nevertheless, Henry George has enjoyed a dedicated following.

[edit] Detailed historical terminology

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In the 1700s it was observed that higher wages and interest will draw additional labor or capital into production. As wages and returns to capital development increased then people came to the cities to work for wages and to help in the construction of capital. The early “capitalists” sought the interest that flowed from industrialization. People who would have died in the countryside were alive because they were able to find employment in the city. But attempting to increase rents merely resulted in unused land. The freeholders of land historically rented or made useful all the land they had at whatever the market would bear. Still, users were willing to pay higher rents for particular sites because these sites offered some beneficial opportunity for production or commerce. But no rent whatsoever was needed to "bring" land into production. In a free market all of the fees paid to insure exclusive use of land over some period of time can be attributed to allocation of land by market forces. It was/is assumed that the user that can/will pay the most for the use of the land will be the most productive user of that particular section of land. This is described as "allocating the land to best use".

Virtually all of the land rent could be assigned to the allocative function using market prices, while only a small portion of wages (the income earned by labor) or interest (the income earned by capital) could be attributed to allocation. This was so, as discussed above, because wages and interest also serve to draw these factors into productive use. Johann Heinrich von Thünen was especially influential in developing the spatial analysis of rents, which highlighted the importance of centrality and transport. Simply put, it was density of population increasing the profitability of commerce and providing for the division and specialization of labor that commanded higher municipal rents. And the high rents determined that land in a central city would not be allocated to farming, but would be allocated instead to more profitable residential or commercial uses.

One implication of the classical analysis is that while a tax on wages or interest income would affect the quantity of labor or capital offered to productive use, almost the whole of land rent could be taxed away without affecting the quantity or quality of available land. Later in the 1800s Henry George, seeing that a properly designed tax on land rent would have none of the efficiency-reducing adverse effects of other taxes, advocated a single tax on land as a way of financing government.

Karl Marx agreed with Henry George and with the classical economists that land rent was a form of exploitation. Landowners were able to get "something for nothing" just because they controlled such important natural resources. To Marx, the landowners received a part of capitalist society's surplus-value that was redistributed from the industrial sector, where workers produced it. However, unlike George, Marx also saw industrial capitalists as rentiers who simply extracted economic surplus from labor, while otherwise contributing nothing to the economy. Henry George was adamant that land and capital are two different factors of production not to be aggregated under the umbrella of "means of production." George saw that economic rent derived from political privilege (primarily land ownership) was the proper place to levy direct taxes while leaving wages and interest untaxed.

In the latter part of the 19th century, as neoclassical economics was being formulated, it was realized that the classical definition of rent made the non-contributory nature of the landowner's participation in economic activities rather too apparent, leading to calls for recovery of publicly created land rents for the purposes and benefit of the public that created them (most famously by the American Henry George), and even for nationalization of land and other natural resources as demonstrably more economically efficient than their private ownership (most notably by Karl Marx). A new basis for consideration of economic rent had therefore to be devised, which would permit a logical and moral defense of long-standing institutional arrangements that many in positions of authority found highly congenial, and that (then as now) few people considered it conceivable (or at any rate convenient) to do without.^[11][12]

In addition, certain kinds of rent-like income flows have long been obtained through other means than ownership of land, such as the royal patent monopolies on trade in salt, spices, silk, etc., or the privileges of exacting tolls from travelers on public roads.^[13] More modern parallels to these sorts of government-issued privileges had also begun to be established by the late 19th and early 20th century in the form of utility monopolies; production, import and export quotas; drug regulation and alcohol prohibition; intellectual property monopolies; labor union certification; and legal barriers to entry in law, medicine and other professions. The common characteristic of the additional income derived from such privileges with land rent income, and what distinguishes possession of such privileges and ownership of land from contribution of labor or capital to production, is that the economic rent incomes obtained thereby are obtained not by contributing anything to the production process, but by controlling others' access to otherwise accessible production opportunities. Since publication of the seminal paper, "The Welfare Costs of Tariffs, Monopolies, and Theft," by Gordon Tullock in 1967, a substantial economic literature has been developed around the concept of rent-seeking behavior and its social and economic consequences.

Consequently, in modern neoclassical economic theory economic rent income is defined not by how it is obtained, but by whether it is greater than some other (typically unknown, or even unknowable) sum: i.e., it is defined as either the difference between the income realized by the owner of a factor of production in some particular use of that factor and the cost of bringing that factor into that use (classical factor rent), or the difference between the income realized in the current use of the factor and the income that would be realized in its next most profitable use (Paretian factor rent). Unfortunately, while these definitions of economic rent usefully encompass the kinds of privilege-based incomes enumerated above in addition to ordinary land rent, they also have the effect of encompassing large amounts of wage and interest income, and introducing substantial uncertainty as to what portions of production can accurately be accounted wages, interest and rent.^{[citation needed]}

[edit] Terminology relating to rent

Gross rent

Gross rent refers to the rent paid for the services of land and the capital invested on it. It consists of economic rent, interest on capital invested for improvement of land and reward for risk taken by the landlord in investing his capital.

Scarcity rent

Scarcity rent refers to the price paid for the use of the homogeneous land when its supply is limited in relation to demand. If all units of land are homogeneous, but demand exceeds supply, the entire land will earn economic rent by virtue of its scarcity.

Differential rent

Differential rent refers to that rent, which arises owing to differences in fertility of land. The surplus that arises due to difference between the marginal and intra-marginal land is the differential rent. It is accrued generally under extensive cultivation of land. The term was first stated by David Ricardo.

Contract rent

Contract rent refers to that rent which is mutually agreed upon between the land-owner and the user. It may be equal to the economic rent of the factor.

[edit] See also

• List of economics topics
• Quasi-rent
• Rent-seeking
• Hotelling rent
• Ricardian rent
• Schumpeterian rent
• Johann Heinrich von Thünen

[edit] External links

• Definition of economic rent at Economist.com
• The Art of Rent, a series of seminars at Queen Mary University of London.
• Rent-Seeking Network Rent-Seeking papers by Behrooz Hassani

[edit] References